Service sector pullback slows, factory orders up

The U.S. service sector shrank last month at the slowest pace since late last year and orders to U.S. factory orders rose in April, but the improvements were incremental and economists say a real recovery will be long and slow.

Service industries such as retailers, financial services, transportation and health care make up about 70 percent of the country’s economic activity. Any turnaround in the sector rests on improved consumer spending.

The Institute for Supply Management said Wednesday that its services index registered 44 in May, up slightly from 43.7 in April. It was the highest reading since last October, when the index was at 44.6.

But it was the eighth straight monthly decline and was slightly below economists’ expectations. Any reading below 50 indicates the services sector is shrinking. The last time the index was at 50 or higher was in September.

Separately, the government reported Wednesday that orders to U.S. factories rose 0.7 percent in April, the second increase in three months.

But the Commerce Department‘s report was below analysts’ expectations, and the government also marked down the March figure to a 1.9 percent drop, from a 0.9 percent decline previously reported.

The financial markets were disappointed by the reports. The Dow Jones industrial average dropped about 90 points in afternoon trading, while broader indices also declined.

Federal Reserve Chairman Ben Bernanke, meanwhile, said Wednesday that the economy will begin growing later this year, but the improvement will be slow.

“We expect that the recovery will only gradually gain momentum,” he told lawmakers. “Businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time, even after economic growth resumes.”

The ISM data signaled that conditions were “nowhere near as bad as late last year and earlier this year. While some further drift upward is likely as the rate of economic decline slows, we do not expect this indicator to flash a sustained ‘all-clear’ signal anytime soon,” MFR’s chief U.S. economist Joshua Shapiro wrote in a research note.

The report from ISM, a Tempe, Ariz.-based trade group of purchasing executives in 18 industries, is based on a survey of the institute’s members and covers indicators such as new orders, employment and inventories.

The latest report on the U.S. services economy comes as the European services sector also is looking better.

A British measure rose past 50 in May, implying expansion. It was the first growth reading since April 2008. Meanwhile, a reading for the 16-nation euro zone’s services sector in May was revised upward to a seven-month high.

In the U.S., six of the service industries surveyed reported growth, including real estate, retail and food services.

But all-important consumer spending dipped 0.1 percent in April, even as Americans’ incomes rose, according to the Commerce Department. It was the second straight month consumers cut back after a spending burst earlier this year. Any growth in the services sector will be fueled by the willingness of consumers and businesses to buy.

The level of new orders, essential for businesses’ expansion, shrank faster, falling back to 44.4 last month from 47 in April, a big disappointment. The new orders are a trigger for ramping up production and hiring, and had risen from 38.8 in March, giving hope of a turnaround. The ISM companion index for manufacturing on Monday showed new orders in May turned positive for the first time since November 2007.

“Everyone was hoping we’d bottomed out, going more sideways” because of the April data, said Anthony Nieves, chair of the ISM’s non-manufacturing survey committee and a vice president at Hilton Hotels Corp. “We’re just not there yet.”

Business activity in May also declined from April. None of the subindexes showed growth.

Employment inched up to 39 in May from 37 the previous month, the sixteenth contraction in 17 months. While the current level is a seven-month high, said Paul Ashworth, senior U.S. economist at Capital Economics, it still implies 250,000 job losses a month in the services sector.

Real estate was one of the sectors reporting an increase in employment, the report said.

The recent uptick in housing activity, especially in areas hard-hit by foreclosures such as Florida and California, is a boon to the industry’s hurting brokers and real estate agents, as well as bank lenders.

But retailers reported a drop in employment.

Retail sales got a bounce at the start of the year as stores used aggressive discounts to lure shoppers. However, economists expect sales to turn lower when chains report their May sales on Thursday.

Jewelry seller Tiffany & Co. said last week that its first-quarter profit sank 60 percent. It maintained its profit outlook for the year, however, saying it had helped offset sliding sales by cutting 10 percent of its staff, or 900 people.

The unemployment rate currently stands at a 25-year high of 8.9 percent. Economists estimate the rate climbed to 9.2 percent in May, and joblessness is expected to hit double digits later this year or early in 2010.

The services sector usually has a slowdown in summer months, and there’s not going to be much of a driver for growth until fall, said Nieves said.